Yields signal longer bear market

DavidW. Tice

Ask them to name a dividend yield, any dividend yield. It can be the yield on the S&P 500, the yield on the Dow or the yield on their favorite stock.

With the gold mine of information at investors' fingertips, I'd make my own bet that dividend yields are among the least sought after nuggets.

That's' a shame. Dividends have traditionally played an important role in the long-term total return picture. In fact, I think the market's current yield is one more indication that stocks remain expensive despite the downdraft over the past year.

According to the Leuthold group the median yield of S&P 500 since 1957 is 3.4%. These days it's closer to 1.1% of late.

Heck the Dow sported a 3% dividend at its peak prior to the '73-'74 bear market.

Admittedly, the stock market's dividend yield is hardly riveting cocktail chatter. Yet it is only in the last half-decade that dividends have been of little consequence in terms of broad market returns. In fact, there was a time when dividends accounted for virtually all of an investor's success.

According to Global Financial Data, stocks provided a return of 5.9% from 1802 to 1900, with dividends (and their reinvestment) accounting for 5.1% (or almost all) of the gains. Over time, the rising prices of the stocks themselves increased in importance. Still, from 1900 to 1995, dividends chipped in 4.9% (almost half!) of the market's 9.8% annual return. More recently, from 1945 to 1995, dividends provided 4.2%, or about one-third of 12.4% annual return from equities.

Even in the latest bull market, dividends were not chopped liver. Dividends and their reinvestment provided 4% of the 17.1% annual stock market return from August '82 through December ' 95. But by 1995, stock prices were so high that the role of dividends diminished. In other words, elevated stock prices meant a lower current yield. As a result, less money was available for reinvestment.

For example, from year-end 1995 through 1999 dividends contributed just 2.1% a year compared to the massive 26.3% total annual return over the period.

The point is, today's dividend dearth is just one more factor that may make the current bear market less bearable.

For example, if you had bought the Dow at the peak of the '73 market and held it through January 1983, you would have found the Industrials only about 2.7% higher 10 years later. But by reinvesting the dividends every quarter, your total assets would have grown by more than 60% over the period nonetheless. That's not a great return for 10 years, but dividends (and their reinvestment) were responsible for almost all of it. But remember, the Dow was yielding 3% in January '73.

Performing the same exercise of buying the '73 market peak with today's paltry yield cuts the increase over the period in half, resulting in a return of less than 3% a year. This bear market, of course, began from much higher levels of valuation, and investors were heavily weighted in tech stocks, most of which pay no dividends at all.

The easy response to such an exercise, besides sudden drowsiness, is to argue that modern tax laws have made dividends less attractive, and investors have no choice but to bank on higher stock prices.

That's partly true, but notice that dividends have typically delivered something in the ballpark of 4% a year until quite recently, a period when capital appreciation was off the charts. In fact, the '80s and '90s were the best back-to-back decades for stocks in 200 years.

The period was so good, in fact, that if market returns merely revert to the long-term average, stocks could go nowhere for some time.

For example, if the S&P 500
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delivered a respectable 7% a year in capital appreciation over the 10 year period beginning in 1995 and ending in 2005, the index would sell for only 1211, or close to current levels. Keeping up the 7% pace through 2015 would put the S&P 500 at 2383, resulting in an increase of about 5% annually going forward. If reality comes anywhere close to this supposition, it would be nice to have more than a 1% dividend to reinvest along the way.

Bottom line? Today's dividend yield is more indicative of a market top than a bottom. The paltry pay outs may be telling investors who think the bear market is over to wait. And then wait some more.

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